Several weeks ago, William O’Brien, the chief executive of Direct Edge, and several of his senior managers took a discreet flight to Kansas City, Mo. Waiting for them at the Charles B. Wheeler Downtown Airport were Joe Ratterman, head of the rival BATS Global Markets, and his team.
Working under cover of secrecy - Mr. O’Brien’s company was code-named “Delta,†while Mr. Ratterman’s was “Blue†- the two sides negotiated many of the finer points of a merger. The talks moved so quickly that their meeting finished an hour ahead of schedule.
The fruits of their efforts were on display Monday morning, as BATS and Direct Edge announced their plans to combine under the BATS name. The goal: to displace the New York Stock Exchange and the Nasdaq atop the world of stock markets.
“It pretty much guarantees you’re going to have a significant force to be reckoned with in the global exchange place for decades to come,†Mr. O’Brien said by phone.
The deal is the latest in the world of market operators, as companies seek more efficiencies and broader global reach by combining. Last year, the IntercontinentalExchange agreed to buy the N.Y.S.E.’s parent, NYSE Euronext, for $8.2 billion. Also last year, the parent of the Hong Kong Stock Exchange paid over $2 billion to buy the 136-year-old London Metal Exchange.
The pressure to join forces is a result of the challenges and changing environment facing exchanges. Technological advances and regulations have encouraged competition between markets, driving down the profitability that the Big Board and Nasdaq once enjoyed.
Both Mr. Ratterman and Mr. O’Brien said in interviews that they had long believed in more consolidation within their industry to harness greater scale and better compete against their older rivals.
BATS and Direct Edge were both formed to take advantage of the seismic changes in the world of stock trading. BATS was founded in 2005 by a programmer at a high-speed trading firm looking to offer lower prices than the Big Board and Nasdaq. Direct Edge’s predecessor was created in 1998, but the company rose to prominence after being sold in 2005 to the big trading firm Knight Capital, which later sold big stakes to Wall Street firms like Goldman Sachs in 2007.
Both companies are profitable on a stand-alone basis, their chief executives said. Last year, BATS reported $101 million in earnings before interest, taxes, depreciation and amortization, and its Ebitda margin was 65 percent.
“Our competitors have lost the ability to be as efficient as we are,†Mr. Ratterman said.
Combining the two will vault the new company past Nasdaq to become the second-largest exchange operator in the United States. Over the last month, exchanges run by NYSE Euronext hosted about 22.5 percent of all stock trading, while Nasdaq’s markets serviced 17.5 percent. BATS and Direct Edge together had 20.5 percent, according to figures from the data arm of BATS, which the rest of the industry also uses.
The combined market operator will keep all four of its parents’ exchanges, which offer slightly different prices and trading systems aimed at different types of customers. Mr. Ratterman will remain chief executive, and the company will stay based in BATS’s home in the suburbs of Kansas City, Kan. Mr. O’Brien will become president, while Bryan Harkins, Direct Edge’s chief operating officer, will take on an unspecified senior position.
While both Nasdaq and the Big Board’s parent companies are publicly traded, the newly enlarged BATS is expected to remain private for some time.
The combined company’s primary shareholders will include some of Wall Street’s biggest trading firms, including Goldman Sachs, Morgan Stanley and the hedge fund Citadel, as well as the private equity firms Spectrum Equity and TA Associates.
Though BATS had tried to go public last year before withdrawing its stock sale amid technical issues, the new BATS is expected to remain privately held by its members for some time, according to Mr. O’Brien.
“You never say never on those things, but right now an I.P.O. is not on the horizon,†Mr. O’Brien said.
The merger deal will also help shore up the two exchanges against the steady disappearance of trading volume as investors have soured on stocks. Other markets have sought to combat the problem by looking for trading opportunities in assets like bonds and derivatives, and moving into new markets around the world.
BATS already runs the largest Pan-European stock exchange, and Direct Edge has been making plans to expand to Brazil. The leaders of both firms said that together they would be looking for chances to expand into bond and currency trading, and to build stock exchanges in places like Japan and Canada.
“The Canadian market is one where we’ve had our eye for quite a while,†Mr. Ratterman said.
The men also say they see opportunities to take existing business from Nasdaq and the New York Stock Exchange. The older companies make a lot of money from selling data to customers, which is possible because of the amount of trading they host. The combined trading volume of BATS and Direct Edge should allow them to come up with their own data offering.
“The choices that customers have, have remained pretty narrow and pretty high cost,†Mr. O’Brien said.
He added that the new company could also move toward opening a business of listing stocks, something that currently only the two older companies do. Because the shareholders in the new company will be the large banks and trading firms that are responsible for a large portion of all stock trading, the new exchange may be a more attractive place for them to send their orders.
“When you have that number of firms around the table, it creates the potential for this combined company to be a part of a lot of change in any part of the market,†Mr. O’Brien said.
Getting to the deal took time. Though Mr. Ratterman and Mr. O’Brien have regularly spoken over the last three years, it was not until April that the two seriously began discussing combining their companies.
Over a meal in May at Acappella, an Italian restaurant in Manhattan’s TriBeCa neighborhood, the two men agreed on many of the important points of any merger, including preserving all four of their exchange platforms.
Several months of negotiations ensued, with BATS receiving advice from Broadhaven Capital Partners and Direct Edge working with Bank of America Merrill Lynch and Evercore Partners. To clear his head, Mr. Ratterman took to a local pool in Kansas City and swam laps.
The end of the merger process happened to coincide with a spate of bad news for one of BATS’s and Direct Edge’s older rivals. On Thursday, a day before the boards of both companies were scheduled to vote on their deal, Nasdaq halted trading for all of its listed stocks because of technical problems.
The breakdown again raised questions about the health of modern stock markets, which are highly dependent on computers to carry out buy and sell orders. Still, a rival’s technical glitch did not daunt BATS’s and Direct Edge’s boards and shareholders, which approved the deal on Friday as planned.
Both Mr. Ratterman and Mr. O’Brien say more work needs to be done, postponing any celebration until the deal’s close, which is expected in the first half of next year.
“We haven’t opened any champagne bottles yet,†Mr. O’Brien said.
